Fording Coal has left the broad umbrella of railway and hotel giant Canadian Pacific to become a stand-alone, publicly traded company. The new, Toronto-listed entity is now known simply as
The break-up of Fording and four other companies —
“[The decision] equips all five companies to pursue even greater success by providing them with growth opportunities and direct access to public equity markets,” says CP Chairman David O’Brien. “It will allow investors to value these industry leaders on a stand-alone basis against competitors, benchmarks and performance criteria specific to each business sector.”
For every CP common share, shareholders received: 0.166 of a new Fording share; 0.684 of a new PanCanadian share; 0.5 of a new Canadian Pacific Railway share; and 0.25 of a new Fairmont share. In addition, preferred shareholders were paid $26 per share.
Fording is Canada’s largest producer of high-quality metallurgical coal for export and is second in the world only to
Fording operates three metallurgical coal mines, Fording River, Greenhills and Coal Mountain, all of which are in the Elk Valley region of southeastern British Columbia. Last year, these open-pit operations accounted for about 84% of Fording’s operating revenue.
Fording also delivered 5.5 million tonnes of thermal coal for domestic energy consumption at two mine-mouth power plants at Genesee and Whitewood in central Alberta. The mines operate on a royalty and cost-plus basis, generating a stable return on invested capital. The Prairie thermal coal operations represented 10% of the company’s operating revenue last year.
Fording is also the world’s largest producer of wollastonite, an industrial mineral used predominantly in the plastics, ceramics and wallboard industries. Its two operations in the U.S. and one operation in northwestern Mexico produced a combined 107,000 tonnes in 2000. The total world market for wollastonite is about 500,000 tonnes. The industrial mineral operations accounted for 6% of Fording’s operating revenue last year.
With 52.7 million shares outstanding, Fording has been trading on the Toronto and New York Stock Exchanges on a when-issued basis since the end of August. Its shares currently sit at $20-21 in a recent high-low range of $27.25-19.81.
Greg Barnes of Canaccord Capital has initiated coverage of Fording with a buy recommendation and set a 12-month target price of $30. “Fording comes to the market offering a number of strengths,” he says. “It is the second-largest producer of metallurgical coal for export in the world; it has a high-quality asset base with significant expansion potential; it will be debt-free by the end of 2002; and it will generate strong annual free cash flow.”
Barnes is convinced that Fording’s market position, financial strength and asset base make it both a potential takeover candidate and a possible consolidator in the coal mining industry (T.N.M., June 11-17/01). “We expect that large players in the coal mining industry, such as BHP Billiton and Rio Tinto, could be interested in Fording. Canadian mining companies that already have an interest in coal, such as Teck Cominco and Sherritt International, may also be considering acquiring Fording.”
He adds that the company will not be shy in looking at acquisition opportunities of its own. Such targets are likely to be open-pit coal mines in politically stable areas throughout the world.
In 2000, Fording earned $34.6 million on revenue of $896.1 million, compared to $26.7 million in earnings on sales of $855.6 million in 1999. Long-term debt stood at $144.2 million after paying down some $100 million. Cash flow was $118.4 million for the year, compared with $99.3 million in 1999. Sustaining capital for all operations is about $40 million per year.
Higher income
Last year, met coal prices reached multi-year lows of US$39.85 per tonne, the result of over-supply and a depressed economy. By comparison, prices in 1997 were US$53 per tonne. Despite a 5% price decrease in the Japanese benchmark price for met coal, Fording’s operating income rose 35% to $85.5 million. The company has managed to diversify its customer base into Europe and Latin America.
Barnes notes that even in 1999, during a period of historic low prices in the export metallurgical coal market, Fording generated earnings and strong cash flow. “This demonstrates that Fording is a well-managed company with a high-quality, low-cost asset base.”
Historically, Fording has realized about 86-88% of the Japanese benchmark contract price on its export metallurgical coal sales. Last year, Asia accounted for 58% of Fording’s exports; Europe, 34%. The company realized an average coal price of US$34 per tonne in 2000. Looking ahead, Barnes expects Fording will realize close to 95% of the Japanese benchmark price.
The Asia coal year starts in early April and runs through to the end of March of the following year. Coal prices are established annually, based on negotiations between mining companies and coal consumers (which, in the case of met coal, are principally steelmakers). An oversupply of met coal has kept prices low for the past several years; however, in the latter months of 2000, world coal markets began to tighten up, leading to price increases in all of Fording’s met coal markets.
Higher prices
Under the 2001 Japanese benchmark contracts, prices for met rebounded 7.5% to US$42.85 per tonne. Fording was also able to negotiate higher prices in Europe, where the range typically had been US$33-34 per tonne. European prices have risen 25-30% to US$44-45 per tonne. In June, the Brazilian steel industry settled for US$45-47 per tonne.
Says Fording President James Gardiner: “It is a significant change in the marketplace, and very significant for Fording in that most of our coal sales were in the lower price markets, where we have been expanding our production. Now many of those prices are higher than the Japanese.”
For the six months ended June 30, revenue totalled $526 million, putting the company on track to exceed $1 billion for the year. Net earnings during the half-year increased to $44.1 million from $12.4 million in the first six months of 2000, while operating earnings rose to $86 million from $34 million. Fording says the results reflect a 12% increase in both coal sale volumes and met coal prices.
The company sold 8.3 million tonnes of met coal from its three British Columbia mines during the first half of 2001, versus 7.4 million tonnes in the year-ago period. Average sale prices for met increased to US$37.55 from US$34.16 per tonne. The met operations generated an operating income of $65.1 million in the first six months of 2001, compared with $13.3 million a year ago. Operating revenue from the met operations totalled $454 million.
The Prairie operations in Alberta delivered 2.6 million tonnes of thermal coal in the first half of the year, generating an operating profit of $22.4 million, compared with a year-earlier profit of $18.9 million on the back of 2.9 million tonnes. Revenue increased to $46.9 million from $43 million.
Slowdown
The industrial minerals division has been hampered by the economic slowdown in the U.S., with income from operations declining to $1.7 million from $4.1 million and with sales falling $4.2 million from the $24.8 million recorded in the first half of 2000.
Fording’s earnings are highly leveraged to changes in export metallurgical coal prices, whereas its mine-mouth operations in Alberta are not affected by changes in international prices for thermal coal.
The company continued to use cash from operations to pay down long-term debt, which was reduced to $93.2 million at June 30, 2001. Cash on hand at the end of June stood at $14.9 million. Barnes expects Fording to pay a 12.5 quarterly dividend, or $26.3 million annually.
States Gardiner: “Our objective is to continue to capitalize on a significant reserve base in all three of our businesses, and to maintain and enhance the leading position we have.
The company has 25 years of proven and probable reserves remaining at both the Fording River and Greenhills met coal operations, plus 14 years of reserves at the smaller Coal Mountain mine. During 2000, coal production totalled 9 million tonnes from Fording River, 4.4 million tonnes from Greenhills and 2.3 million tonnes from Coal Mountain. Proven and probable metallurgical coal reserves for the three mines totalled 367 million tonnes at June 30, 2001. Fording has an additional 1.24 billion tonnes of measured and indicated bituminous coal resources neighbouring its mine operations, plus a further 3.55 billion tonnes of inferred resources.
“We have some drilling to indicate that we have [additional] economic reserves, but we have not brought those reserves into the mine plan,” says Gardiner. “We don’t have to. We’re fourteen to twenty-five years out with the proven reserves that we have.”
Constant demand
Demand for export metallurgical coal has remained fairly constant for the past 20 years, with a relatively flat line growth that correlates to the size and operating nature of the steel industry’s blast furnaces. “The amount of steel that’s coming out from those blast-furnace operations really doesn’t change a whole lot,” says Gardiner, “and the amount of coking coal that they’re consuming probably changes even less.”
The blast furnaces run pretty much the same through all parts of the economic cycle. “You cannot stop and start those blast furnaces; they have to run,” he explains. “If you shut them down, they freeze up and it’s game over.”
The met coal business has been a story of oversupply. However, for the first time in 20 years, there is now a balanced market. Australia, Canada and the U.S. supply most of the 130-million-tonne-per-year seaborne metallurgical coal market. U.S.-source supply has dramatically fallen off in recent years. In 1997, the U.S. delivered some 47 million tonnes of met coal to the market. Today, Fording estimates U.S. exports are around 21 million tonnes. The major part of that reduction is coming out of deep, high-cost underground mines in the Appalachians. “They are running out of economic reserves, and because of structural problems, we believe they cannot come back to the position they had formerly,” says Gardiner.
In recent years, Canada has lost three met coal mines as a result of depleted reserves. “You add that to the U.S. situation and it means we have lost more than 30 million tonnes of high-quality metallurgical coal from the marketplace out of a total demand of 130 million tonnes,” explains Gardiner.
Fording also holds a strong position in sub-bituminous (thermal) coal reserves in Alberta, with 850 million tonnes of proven and probable material under mine plan at either existing or proposed power stations. Another 818 million tonnes are categorized as measured and indicated, with some 6.17 billion tonnes falling into the inferred category.
Most economical
“If you added it all up it would amount to something like 50 billion barrels of oil equivalent on an energy basis,” says Gardiner. “We believe that, in the next decades to come, and probably over hundreds of years, coal will continue to be a major part of the energy scene in North America.” The reason, he points out, is that coal will likely remain the most economical way to produce base growth electricity.
Fording is in the midst of feasibility studies on two potential coal-fired power-generating plants. Documents were recently filed with the Alberta government to proceed to public consultation and permitting stages on the Brooks power project, 180 km southeast of Calgary. Over the next few months, an environmental impact assessment will be completed and regulatory applications filed.
Also, Fording’s 50%-owned Genesee operation is expected to expand production by almost 50% in 2004 to provide coal for a third generating unit.
Barnes valuation of Fording ranges from a low of $24.10 per share based on a 10.3-times multiple of projected 2002 earnings to a high of $31 per share based on a 5.5-times EV/EBITDA multiple (EV/EBITDA = enterprise value/ earnings before interest, taxes, depreciation and amortization). “We believe that Fording will likely trade at the higher end of this range as investors become more comfortable with the company and gain a better understanding of the metallurgical coal market,” states Barnes. “We also expect Fording’s share price could attract a takeover premium. Our 12-month target price is $30 per share.”
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